In Tang v. Zhang2013 BCCA 52, the British Columbia Court of Appeal considered the interpretation of “deposit” clauses in standard form contracts for the purchase and sale of real estate. The key issue was this: where a buyer fails to complete a real estate purchase, and has paid a deposit that the contract states is to be forfeited to the seller “on account of damages”, must damages be proven in order for the seller to retain the deposit?

The Court held that a deposit will generally be forfeited without proof of damages, subject to a clear expression of contrary intention in the contract. This decision clarifies the law in British Columbia and resolves a conflict between prior inconsistent decisions.

Background

The sellers entered into a standard form contract to sell a residential property for approximately $2,000,000. The buyer paid a deposit of $100,000. The contract provided that if the buyer did not complete the sale, “the Seller [could], at the Seller’s option, terminate [the] Contract, and, in such event, the amount paid by the Buyer [would] be absolutely forfeited to the Seller … on account of damages, without prejudice to the Seller’s other remedies.”

The buyer paid the deposit, but failed to complete the transaction. The sellers subsequently went to court seeking a declaration that the deposit was absolutely forfeited to them. In the meantime, the sellers managed to sell the property to another buyer at a higher price. As a result, the seller did not suffer any damages as a result of the buyer’s failure to complete the sale.

The trial judge observed that the contract provided that the sellers “were only entitled to the deposit ‘on account of damages’” in the event that the buyer did not complete the sale. The trial judge interpreted this to mean that the sellers did not have an unconditional right to the full deposit; instead, they only had a right to claim proven damages out of the deposit funds. Because the sellers had suffered no damages, the buyer was entitled to the return of the deposit.

Decision

The sole issue on appeal was whether the deposit was absolutely forfeited without proof of damages.

The Court began by reviewing the legal principles that govern deposits. The Court observed that the common law supports the notion that, in general, a deposit is lost by the party who fails to perform a contract, even in the absence of damages, on the basis that a deposit is “not merely a part payment”, but also a practical mechanism to “creat[e] by the fear of its forfeiture a motive in the payer to perform the rest of the contract.”

The Court held that although the question of whether a deposit is forfeited is a matter of contractual interpretation, a deposit is generally forfeited without proof of damages. This is consistent with the purpose of deposits, which is to motivate contracting parties to carry through with their bargains.

However, the Court noted that the mere act of labeling a payment as a “deposit” in a contract will not permit the parties to “immunize [the payment] from judicial scrutiny.” A court is not precluded from considering whether a “deposit” is in fact a penalty (in which case relief from forfeiture is available at common law), or unconscionable (in which case relief is available in equity). The Court observed that a deposit of up to 10% of the purchase price has generally been regarded as reasonable, and noted that there was an instance in which a deposit of 20% was regarded as reasonable.

The Court expressly rejected the argument that the phrase “on account of damages” should be interpreted to limit the forfeiture of a deposit to proven damages. In the Court’s view, the phrase was intended to mean that “in any action by a vendor to recover damages against a defaulting purchaser for breach of contract, the amount of the deposit would be counted toward (or “on account of”) such damages.” Seen in this manner, “[t]he phrase forecloses double recovery if damages are proven”, which is “not inconsistent with the nature of the deposit as a ‘guarantee’ of performance which encourages contracting parties to complete their contracts in accordance with their terms.”

Tang does not preclude parties to a contract from providing that a deposit will not be forfeited unless damages are proven. However, in light of the Court’s reasoning, doing so would appear to require the use of language that clearly and unambiguously expresses the parties’ intentions to negate the general rule and the policy rationale underlying it.

 Subscribe to this blog by email, in a reader, or follow it on Twitter

In Southcott Estates Inc. v. Toronto Catholic District School Board, 2012 SCC 51, the Supreme Court of Canada considered whether a plaintiff in a case involving a failed real estate transaction was excused from mitigating its losses on the basis that it had made a claim for specific performance.

Although the Court recognized that a plaintiff’s refusal to mitigate may be reasonable if the plaintiff had a “substantial justification” or a “substantial and legitimate interest” in specific performance, the Court held that the plaintiff had no such interest because the property was intended as an investment and had no peculiar or special value to the plaintiff.

Background

The plaintiff, Southcott Estates Inc. (“Southcott”) was a single-purpose company incorporated solely for the purpose of a specific land purchase. It had no assets other than money advanced to it by its parent company for the deposit relating to the land purchase.

Southcott entered into an agreement of purchase and sale for a specific property with the defendant, the Toronto Catholic District School Board (the “Board”). When the Board failed to satisfy a condition and refused to extend the closing date, Southcott brought a claim for specific performance of the contract, and argued that it was not required to mitigate its losses by purchasing a different property.

The trial judge refused to award Southcott specific performance and, instead, awarded damages to Southcott. On appeal, the Court of Appeal concluded that the Board had breached its contractual obligations, but that Southcott had failed to take available steps to mitigate its losses. As a result, the Court of Appeal reduced Southcott’s damage award to a nominal sum.

Decision

The key issue on appeal was whether a plaintiff must mitigate its losses where the plaintiff has made a claim for specific performance.

The majority reasons, penned by Madam Justice Karakatsanis, recognized that “there may be situations in which a plaintiff’s inaction is justifiable notwithstanding its failure to obtain an order for specific performance.” In particular, “[i]f the plaintiff has a ‘substantial justification’ or a ‘substantial and legitimate interest’ in specific performance, its refusal to purchase other property may be reasonable, depending upon the circumstances of the case”.

In the Court’s view, this was not a case where the plaintiff could reasonably refuse to mitigate. The Court began by observing that “[a] plaintiff deprived of an investment property does not have a “fair, real, and substantial justification” or a “substantial and legitimate” interest in specific performance unless he can show that money is not a complete remedy because the land has “a peculiar and special value” to him. In this case, Southcott had no “substantial and legitimate” interest in specific performance because the land had no peculiar or special value to it. Rather, Southcott had simply “engaged in a commercial transaction for the purpose of making a profit”, such that “[t]he property’s particular qualities were only of value due to their ability to further profitability.”

As a result, the Court held that Southcott owed a duty to mitigate its damages by purchasing an alternative property, notwithstanding its specific performance claim.

In light of the decision, a plaintiff with a claim of specific performance must carefully evaluate the strengths and weakness of its claim. If a plaintiff chooses to pursue its claim of specific performance and declines to mitigate its losses in the interim by buying an alternative property, the plaintiff must be prepared to suffer a reduction in its damage award in the event that a court rejects its claim of specific performance and finds that the plaintiff unreasonably failed to mitigate its losses.

Subscribe to this blog by email, in a reader, or follow it on Twitter

Follow

Get every new post delivered to your Inbox.